George Soros's Q4 Activity Revives Investor Interest In Marathon Digital

Summary Billionaire investor George Soros revealed an investment of $8,984,659 in convertible notes of Marathon Digital. Marathon Digital stock has more than doubled this year, aided by short-squeeze rumors on Reddit and rising Bitcoin prices. This analysis aims to shed light on the company's profitability profile, balance sheet health, and the changing competitive landscape. Marathon Digital Holdings, Inc. (MARA) stock surged on February 14 as Soros Fund Management led by billionaire investor George Soros revealed an investment of $8,984,659 in convertible notes of the company that could be converted into 39,600,000 common shares. Not surprisingly, Mr. Market welcomed this news, given that George Soros has built a reputation for exploiting mispriced bets in capital markets. Cryptocurrencies have started 2023 on the right foot - at least from a market performance perspective - with Bitcoin (BTC-USD) prices up more than 33% YTD. MARA's run continued yesterday too, with the stock ending the day up more than 18%. This analysis aims to shed light on the company's profitability profile, balance sheet health, and the changing competitive landscape. Months Or Decades Away From Profitability If the above subheading confused you, that was exactly what I was looking for. The primary driver of a Bitcoin miner's profitability is the underlying Bitcoin prices, which makes Bitcoin mining operations similar to mining assets such as gold and silver. Bitcoin prices are highly volatile and predicting future prices is next to impossible although some analysts have come up with price targets that cannot be rationally justified using math. Because of the high volatility of Bitcoin prices, it is difficult to predict when Marathon Digital will turn a profit. Investors, however, need to consider a few other factors in addition to Bitcoin prices to determine the potential profitability of the company. The cost of electricity. The price of Bitcoin mining equipment. The competition in the industry. Using Q3 data, Marathon Digital will breakeven at a Bitcoin price of $16,646 from a cost of mining revenue perspective, but as illustrated below, Bitcoin prices will have to rise astronomically for the company to breakeven from an operating profit perspective. Exhibit 1: Breakeven Bitcoin prices for public miners as of Q3 2022 Blockware Solutions Because Bitcoin prices are highly volatile, Marathon Digital might end up with profits as soon as just a few months if Bitcoin takes off, but the opposite is also true. One of the main points raised by bulls is that Marathon Digital's hash rate will grow exponentially aided by the company's investments in miners. In its latest investor presentation, Marathon Digital highlighted how its hash rate could swell to 23 EH/s by mid-2023 from just 3.8 EH/s reported in Q3 2022. Exhibit 2: Projected hash rate growth Investor presentation These projections look rosy but to add some context, the company initially guided for 13.3 EH/s by Q2 2022, a target that Marathon Digital failed to accomplish. As a growth-oriented investor, I am willing to take calculated risks to beat the market in the long term but I believe investors need to be cautious about investing in a Bitcoin miner solely based on hash rate growth projections. Leverage Is A Concern Marathon Digital raised close to $750 million in a convertible note offering in Q4 2021, and the company used the majority of these proceeds to purchase Bitcoin mining equipment aggressively. In December 2021, the company struck a deal with Bitmain to purchase 78,000 Bitcoin miners for a staggering $879 million. According to the purchase agreement filed with the SEC, Marathon Digital agreed to pay over $11,000 per unit for Bitmain S19 machines. Exhibit 3: Delivery schedule and price details as per the purchase agreement with Bitmain Company filings Company filings The company entered a non-fixed price deal with Bitmain and under the payment terms, Marathon Digital agreed to pay 35% of a batch's price at least 6 months before shipment. Since Marathon struck this deal, prices of Bitcoin mining equipment have plummeted. Exhibit 4: Bitcoin ASIC price index Hashrate Index The above prices are calculated based on unit prices and their hash rate output, and in summary, unit prices have fallen more than 85% from the highs seen in 2021. The company's decision to purchase mining equipment at elevated prices might come back to haunt investors in the coming years with its convertible debt maturing in December 2026. In addition to the convertible debt, the company has secured two other credit facilities; a $100 million term loan and a $100 million revolving credit facility. Both these loans require the company to keep Bitcoin as collateral at the time of drawing from these facilities. In Q3, Marathon Digital used $50 million from the term loan at a cost of around 9% (prime rate plus 1.75%) and used $50 million from its revolving credit facility as well. The company had to use 9,490 Bitcoin as collateral for these loans. Investors, with this understanding of Marathon's capital structure, need to make the necessary adjustments to calculate the unrestricted liquidity of the company at any given time without using the total Bitcoin holding as a proxy for unrestricted liquidity. In general, investing in a highly leveraged Bitcoin miner seems inherently riskier than investing in Bitcoin itself as companies could go bankrupt amid liquidity issues. In contrast, direct Bitcoin investors are not exposed to this risk. Short-Term Volatility Is On The Cards Marathon Digital stock has more than doubled this year (+133%) aided by rising Bitcoin prices and a notable improvement in investor sentiment resulting from George Soros's association with the company. Another possible reason behind the recent gains is the rising interest in MARA among traders looking for potential short-squeeze opportunities. The Reddit "Shortsqueeze" community with 161,000 members has been actively discussing the outlook for MARA stock as a one-of-a-kind short squeeze opportunity, and these discussions have led to a renewed interest in the company among traders. Competitive Landscape May Improve Some Bitcoin mining companies have come under pressure with recent macroeconomic challenges, forcing them to go out of business. Core Scientific, Inc. (CORZQ), one of the largest crypto mining companies in the U.S., filed for bankruptcy protection in December, triggering widespread investor fears for the future of its rivals. For Marathon Digital, these bankruptcies may come as a blessing in disguise as a potential decline in hash rates will allow the company to make more bang for the buck with reduced competition. Takeaway Marathon Digital, one of the largest public Bitcoin miners in the U.S., is investing aggressively to bring more mining rigs online. This strategy will help the company mine more Bitcoin in the coming quarters, thereby relieving some pressure on its liquidity profile with the company now starting to sell Bitcoin to fund its business operations. Despite some positive developments, as a long-term-oriented investor, I do not feel comfortable taking a position in MARA given that investing in Bitcoin directly seems a better option if I were to invest in cryptocurrencies.